The reputation of exchange traded products that give investors access to commodities took a hit this month when one of the largest exchange traded commodities pools — the $3.61 billion U.S. Natural Gas Fund LP (UNG) — was forced to stop issuing new shares.
The fund, managed by United States Commodity Funds LLC of Alameda, Calif., stopped selling new shares July 7 because it reached the limit of shares it was approved by regulators to create.
It filed papers with the Securities and Exchange Commission on July 5 to offer more shares but was still waiting for permission to do so at press time.
As a result, the fund, which is similar to an exchange traded fund, was trading last week at a premium to its net asset value. That is because while the fund can still accept redemptions, it is the constant creation and redemption of shares that allows it to trade in line with its NAV.
“I think [the situation is] hugely important for every investor,” said Jim Lowell, a partner and chief investment strategist of Adviser Investment Management Inc. of Newton, Mass., which manages more than $1 billion.
To be sure, investors who think that they are investing in an ETF-like product don't want to wake up to premiums or discounts, he said. If they did, they would buy closed-end funds.
“I think it will scare some investors away,” said Paul Justice, an analyst with Morningstar Inc. of Chicago.
At the very least, it will cause investors to dig deeper into the differences between traditional ETFs registered under the Investment Company Act of 1940 and other exchange traded products, he said.
For example, the U.S. Natural Gas Fund is an exchange traded commodities pool registered under the Securities Act of 1933.
Unlike a traditional ETF, it must register on a regular basis to offer new shares.
And when it does register for new shares, the registration statement is subject to review by the SEC, the
Financial Industry Regulatory Authority Inc. of New York and Washington, the
Commodity Futures Trading Commission and the Chicago-based National Futures Association.
That isn't necessarily a problem.
But the growth of the U.S. Natural Gas Fund — from about $400 million in January 2008 to almost $4 billion this month — may have raised concerns with at least one of the regulators.
Several industry experts have suggested that the fund's meteoric growth helped drive up the price of natural gas artificially.
As a result, the CFTC — which is charged with ensuring an orderly commodities market — may be holding up approval of the fund's issuing more shares, they said.
Fanning the rumors was a July 7 statement by CFTC Chairman Gary Gensler: “The commission will be seeking views on applying position limits consistently across all markets and participants, including index traders and managers of exchange traded funds.”
The CFTC declined to comment further.
But John Hyland, chief investment officer at U.S. Commodity Funds, said that it seems highly unlikely that the CFTC is holding up the U.S. Natural Gas Fund's application to issue new shares.
“We have no reason to believe that's true,” he said.
NOTHING SINISTER
That the fund reached the limit of shares it could create before getting permission to issue new shares was regrettable, but there is nothing sinister about it, Mr. Hyland said.
“This might be a little longer than some of the others' cycles [to get approval], but it's probably not going to be the longest,” he said.
The message investors should take away from this situation is that you should understand what you are investing in before you decide to invest, Mr. Justice said.
Adding commodities can be a great diversifier, but getting exposure to commodities through an exchange traded commodities pool can be problematic, he said.
Even with the potential problems, however, such exchange traded products still offer retail investors the best access to commodities, Mr. Lowell said.
“There are other ways to structure commodity positions, but none of them is as elegant, as executable and as cost-effective as the ex-change traded option,” he said.
E-mail David Hoffman at [email protected].
